Reforming Canada’s Employment Insurance System

A proposal that encourages individual accountability, more stable and better paying jobs, shares the risks of unemployment, while providing a savings pool for Canadians — a system fit for the modern economy

Imagine you own a 2010 Honda Accord, have been driving with a spotless record for 15 years, and live in a low crime neighbourhood, lock your car in your garage at night, and have a car alarm. Now imagine you have a 23 year-old neighbour, they have had multiple accidents, park their car on the road, and they drive a $55,000 luxury SUV. Would you be happy to pay the same car insurance premium as your neighbour? Well this is how Canada’s Employment Insurance (“EI”) works. Premiums don’t vary by how many times you have claimed, if your employer routinely lays people off, how long your periods of unemployment last, or if you make efforts to reduce the likelihood of claiming such as up-skilling or moving to where you have better job prospects. It does not make much sense does it?

With EI premiums in Canada averaging nearly $2,000 per employee, nearly $23bn in total annual EI premiums, and $22bn in claims, EI is one of Canada’s largest federal programs. For a program of such magnitude that economists, politicians, business, and many Canadians don’t believe is fit for purpose, it is high time that politicians found the courage to fundamentally reform EI. I propose a solution that is equitable, sustainable, incentivises better economic and social outcomes, all while providing Canadians with a nice financial incentive to modify the system…. cash. There is a solution available to government that could leave the average worker with a cash account with $295,000 when they reach the age of 65. With an incentive like this, politicians should be able to overcome the political heat that will come with any change to EI.

There are a few key problems with Canada’s EI system that make if both inefficient and ineffective.

• No experience rating by employer — It has been well documented that because premium rates are the same for employers regardless of how often they make staff redundant, that some employers, employees, and whole industries have developed strategies to maximise EI payouts. What this does is have more dynamic and viable businesses and industries subsidise those that are less financially viable, exactly the opposite of what should be happening if we want a sustainable and dynamic Canadian economy. Canada’s EI system should not cross-subsidise precarious businesses at the cost of overtaxing dynamic companies that could grow faster, create more jobs, and pay higher wages if their EI premiums better matched their risk of laying off staff.
• Different eligibility criteria by region — Many people may not realise that the ability to claim EI and the duration of benefits payments varies across Canada. The system in place is the exact opposite of what in insurance is termed ‘experience rating’, where those at greater risk pay greater premiums. Instead, Canada’s EI system makes it easier to claim and pays EI benefits for longer where there is greater the risk of unemployment. This perverse situation incentives people and businesses that pose a greater risk of EI claims to not adapt to changing economic or social forces. We should be fostering businesses that are profitable, are growing, and provide quality stable employment, instead our EI system does the opposite.
• Inequitable treatment of the same or similar employees —Picture this example of how differing eligibility works in practice. Two women work at a warehouse in Halifax, have worked for the same number of hours and earn the same wage, the only difference is that one commutes 45 minutes into the city to work. They both get laid off, but due to the geographic difference of where they sleep the one who lives in city gets no benefits but the woman who lives in the countryside gets $450 a week for 22 weeks. Two people with the same employment, having paid the same EI premiums, but getting vastly different EI benefits. This is simply inequitable and not justifiable.
• No penalty for repeated claims — Canada’s EI system also has no penalty for repeated claims. Some analysis has found that up to 40% of EI claimants had claimed in 3 of the preceding 5 years. When you start to claim that frequently EI stops looking like insurance and more like a way of life. Without a penalty for repeated use individuals have reduced incentive to retrain, commute, or move to improve their employment prospects. The same dynamics apply to businesses that routinely layoff staff, if their premiums don’t change they lack an incentive to adapt to provide more stable employment.
• Limited coverage of the self-employed — Coverage for the self-employed under the current EI scheme is voluntary, which has an in-built moral hazard that only those self-employed people expecting to claim sickness benefits, for instance, would join the scheme. The current EI program also does not cover the self-employed for unemployment claims, coverage is limited to sickness, maternity, paternity, and caregiving benefits and only to those self-employed that join the scheme voluntarily. This is a major policy gap as there expected to be significant growth in the self-employed and gig-economy in the future and the current program may stifle entrepreneurialism, as people starting new businesses are not eligible for unemployment benefits if their business fails, which is part of the creative destruction nature of a vibrant economy.

These are just some of the economic and insurance based problems with EI. When you combine these with Canada’s regional frictions, the EI program becomes a political hot potato that politicians change at their peril. However, continuing EI in its current form risks lower economic prospects for Canadians and the rise of regional hostilities, particularly in western Canada. Here are just a few of the political challenges that the current EI model presents.

• Individual inequity — Two people in different parts of the country, but being employed at the same time can get vastly different EI payouts all else being equal. Research conducted in 2017 for instance, found that two “workers in identical circumstances, with equivalent private resources and contribution hours, can be treated very differently by the EI system. For example, a worker in London, ON, with a 6.2 percent regional unemployment rate, would need to contribute for a minimum of 700 hours before receiving a maximum of 38 weeks of benefits. In contrast, a worker in eastern Nova Scotia, which has an unemployment rate of 13.6 percent, would need only contribute for 420 hours to receive up to 45 weeks of benefits.” Amazingly, seasonal fisherman in some cases only need to earn $2,500 a year (something that can be achieved in one day of a high value catch) to be able to claim EI for the next 26 weeks. Fishermen are the only type of worker that get this special EI treatment. Why not tree planters who only work in the summer or oilfield workers that drill in the winter months? When a social program is so evidently inequitable in how it treats people in different parts of the Country, support for the program will suffer as well the the stability of the Canadian federation.
• Regional subsidies —All politicians, economists, and many people recognise that EI is not just insurance but a form of regional subsidy, which can buy votes. It was no surprise that when Chretien in the 1990’s tried to address some of the flaws in Canada’s EI system that the office of one of his Cabinet Ministers was mobbed and the Liberals lost many Atlantic Canadian seats. These reforms were shortly rolled-back resulting in a Liberal surge at the next election. Due to the structure of eligibility of the EI system, which means it is not only easier to qualify for EI in Atlantic Canada but the period of benefits is also longer than elsewhere in Canada, along with special eligibility for fisherman, the current EI program serves as a massive wealth transfer to Atlantic Canada. For instance from 1981 to 2010 Newfoundland & Labrador received $14.4bn more in EI claims than they paid in premiums, while over the same period Albertans contributed $17.9bn more in premium than they received in claims. This pattern of regional subsidy continues today.
• No incentive to adapt— One would assume that provinces that have received more EI claims payouts than premiums paid over the decades would have seen positive economic outcomes. However, because Canada’s EI system actually incentivises people, businesses, and even governments to not adapt but to adjust their behaviours to maximise claims payouts; research has found that historically heavily EI dependent regions have suffered economically. For instance, research into the impact of Canada’s much more generous EI system on employment and economic growth on New Brunswick versus its southern neighbour, Maine found that while the two regions share similar climates, remoteness, and economies (in 1940) EI had a materially negative impact on the economic prospects of New Brunswick. The generosity of Canada’s EI system resulted in six times more New Brunswick males (29.5%) as a share of the population claiming EI than those in Maine (5.7%), the unemployment rates diverging with New Brunswick’s being more than 50% than Maine’s, an EI claims as a share of GDP being six times greater in New Brunswick than Maine. Canada’s EI system also contains no incentive for people to move to regions with strong labour markets. The perverse incentives in Canada’s EI system actually trap people, industries, and regions into EI dependency.

Canada’s EI program fails equity principles — it treats nearly identical claimants, has perverse incentives for individuals, companies, industries, and governments to become dependent on EI, taxes growing successful companies to subsidise failing ones, which all lead to less stable employment for individuals and lower incomes. Research has found that EI systems that have experience rating, meaning firms and/or claimants pay more and/or receive reduced benefits based on the risk they pose such as is the case for home or car insurance, results in GDP increasing, unemployment decreasing, wages increasing, and 82 out of 95 business sectors benefiting from the change. With all this, it is clear that Canada needs to reform its EI system.

So how could we reform EI to increase the economic wellbeing of Canadians, provide more stable employment, and reduce regional tensions? Well as usual, your non-economist has a few ideas.

Individual EI Accounts

With the average annual employment income of Canadian’s being $48,000 according to the most recent 2018 Statistics Canada figures, the average employee in Canada paid $797 in EI premiums, with their employer contributing $1,116. This means that the average working Canadian contributed $1,913 in EI premiums in 2018.

Imagine a world where these EI premiums don’t go into the general EI fund but instead go into individual EI accounts. Using some very basic assumptions, a 25 year-old working for 40 years, contributing $1,913 a year into the account, and investing it in a Royal Bank of Canada’s ‘Balanced Portfolio’ fund that has a 10-year annual return of 7.1%, the fund would grow to nearly $392,000. This scenario assumes that the employees wages are static over their career, which is not reasonable. If we assume that wages increase by 3.2% a year, which is in-line with the EI program’s Actuarial Report the individual EI pot grows to nearly $590,000 by the time the employee looks to retire at 65, assuming they don’t make an EI claim.

These individual EI accounts could be used by workers to payout EI claims with payouts and eligibility being the same across Canada. If the account did not have enough money the government would ‘loan’ the account money with future EI premiums topping it back up. At the end of someone’s working life any money in the account could be converted into an RRSP to retirement. The risk to government of this model is that during a recession a large number of individual EI accounts require loans so the government needs to come up with significant funds out of general revenues just as tax revenues are decreasing.

This is the model proposed by Justin Hatherly from the Atlantic Institute for Market Studies. It is based on a model use in Chile where there is evidence that people respond to the EI system by more quickly finding more stable employment in order to maximise the value of their individual EI accounts.

But rather than move to a purely individual account EI system, which could leave some individuals with large negative individual EI account balances and the government scrambling for money during a recession, I propose a mixed model.

EI Accounts & Insurance

My proposed model includes an element of risk sharing, meaning insurance and social solidarity with individual incentives to reduce EI claims via an individual EI account. For simplicity I propose that 50% of all EI premiums go to a government EI fund to provide unemployment insurance, with the other 50% going to individual EI accounts.

This model enables the government to accumulate funds to ‘loan’ to EI claimants who don’t have enough money in their individual EI accounts to pay valid claims. This pre-funding of the government’s loan should enable governments to avoid large financial shocks in periods of high unemployment. It also provides the government fund with cash to pay for other incentives built into my proposal, such as relocation grants.

The contributions held in individual EI accounts and the government’s EI fund would be administered by a Crown Corporation at arms-length of government, staffed by professional asset managers with the aim to maximise risk-adjusted returns for the assets. The board of directors would include representation from workers, businesses, governments, and academics.

The goal of the government’s EI fund would be to ensure that it has sufficient assets to cover economic shocks over a 15-year cycle. Any surplus assets in the government fund would be retained to cover potential future shortfalls. Each 15 years a detailed actuarial review of the government fund would be conducted with any deemed surplus being transferred to the central government in recognition of the financial backstop it provides the fund, while any deemed shortfall would need to be made up by the government. These goals, governance, and oversight should ensure that the government’s EI fund is not used for political purposes, that short-term surpluses don’t get ‘raided’ by the government of the day, and that the fund is secure and stable for the long-term benefit of workers.

Leaving the investment of individual EI accounts with the professional fund managers of a Crown Corporation protects individuals who are less financially literate. The professional management of the funds within individual EI accounts should enable Canadians to grow their accounts in a way that maximises upside while managing downside risk. If the average worker participated in this scheme and made no claims, by the time they were 65 their individual EI account could have nearly $295,000 in it.

So how might such a system work in practice?

• Individual Premiums — Recognising that the choices of employers and employees have an impact on unemployment, EI premiums should be payable by employers and employees. However, to not discourage the hiring of people who may have been unemployed before, the premium paid by individuals and that goes into the individual EI account should be the same and not experience rated. Using 2018 data that would mean that the average employee would contribute $956.50 annually to their EI account. Because the money within the individual EI account belongs to the employee, there is no need to experience rate their premium as employees will have a strong financial incentive to do whatever is required to maintain stable employment in order to grow their EI account balances.
• Employer Premiums — Because my proposal does not include employer EI accounts and the government provides a form of unemployment insurance, via loans to individual EI accounts, in order to not cross-subsidise employers who routinely lay off people, the employer EI premiums would be experience rated. This means that employers that historically lay people off more and/or for longer periods would pay more premium. Experience rating for workplace injury insurance via Workers Compensation Boards, where employers with more accident claims pay more premium, has been found to have a positive impact on employers investing in safety to reduce injuries and premiums. Similar incentives would be created via experience rating for employer EI premiums, encouraging employers to adapt to provide more stable employment. These adaptations could include training programs for staff, investing in equipment to increase efficiency, or altering employment models to minimise employee layoffs. Employer premiums would be set actuarially using transparent claims experience data, with premiums capped at three-times (300%) of the employee rate to avoid pushing companies with marginal profitability into bankruptcy, while providing them with an incentive to adapt their staffing and technology to reduce layoffs.
• Eligibility — To ensure equity for employees across Canada, eligibility rules for making EI claims would be standardised. This would remove any regional disparities to who is eligible to make an EI claim, meaning similar workers being laid off form similar jobs but in different parts of the country would be eligible for EI at the same time under the same rules. There would be no unique programs targeted at particular regions or professions, such as self-employed fishers.
• Self-Employed Eligibility — Unlike today, the self-employed would be eligible for benefits. To avoid moral hazard of the self-employed only paying into EI when they think they may need the benefits or opting out once they have received their benefits, participation in EI would be mandatory for the self-employed. This would provide a cushion for the increasing number of workers in the gig-economy, a type of employment that is set to increase. As the self-employed don’t have the usual ‘employer premiums’ they would be required to contribute both the employee and employer premiums. In terms of unemployment benefits for the self-employed, because the self-employed have a direct ability to make themselves ‘unemployed’, in order to avoid fraud or ‘gaming’ the system, the self-employed would need to have contributed to EI for at least 12 months in the previous 24 before an unemployment claim would be payable and the experience rating for the ‘employer’ portion of the self-employed EI premium would have a cap of five-times (500%) that of the employer rate based on previous unemployment claims experience. This would help offset the strong element of moral hazard in providing unemployment benefits to the self-employed, but provide unemployment, sickness, paternity, maternity, and caregiving benefits to the self-employed on part with that of traditional workers.
• Claims Amounts — As above, to ensure equity the formula for claims payouts would be standardised so that similar claimants living in different parts of the country would receive the same weekly claims benefit.
• Claims Durations — The length of time that EI benefits are payable would be standardised. Any regional variations would be eliminated so that similar claimants in different parts of Canada would get EI benefits for the same amount of time.
• Education Incentives — In order to encourage workers to maximise their employability, wages, and employment stability program would enable employees to ‘borrow’ at nil interest from their EI account (topped by the government EI fund if there is a shortfall in the individual account) up to $15,000 in their lifetime to pay for accredited courses of education (e.g. trades, college, university, professional qualifications). Encouraging lifelong learning and retraining should help to reduce unemployment and increase wages.
• Relocation Incentives — To incentivise people to move from low employment regions to areas short of workers, the scheme would allow people to ‘borrow’ at zero interest from their EI account (topped by the government EI fund if there is a shortfall in the individual account)up to $10,000 in their lifetime to relocate for a job, with $5,000 being non-repayable as a grant from the government’s EI fund. This should encourage people to move to where they can access stable higher-wage employment, benefiting families and businesses short of qualified workers.
• Sickness, Maternity, Paternity, & Caregiving Benefits — The approach would continue with offering shot-term sickness benefits, maternity, paternity, and caregiving benefits as is the case today. The employer portion of the EI premium would not impacted by employees making these types of claims, meaning there would be no experience rating for these types of claims. This would avoid employers being financially penalised by employees taking benefit of maternity or sickness benefits. The cost of these benefits would be very much ‘socialised’ and shared across society, recognising the benefits of building solid healthy families.

Nobody said reforming Canada’s EI system would be easy! Many politicians have paid a price for trying to reform the system. However, the social and economic costs of the current system are not helping individuals, families, or businesses. It is perverse that research from the Canadian Federation of Independent Business found that 20% of businesses in Atlantic Canada had been asked by employees to be laid off so that they could collect EI. At the same time, regions of Canada with high unemployment also have some of the highest labour shortages and use of temporary foreign workers. Why aren’t unemployed Canadians doing these jobs?

It is clear that Canada’s EI system leads individuals and businesses to ‘game the system’ to maximise EI payouts, discourages people from moving or taking on alternative employment where there are labour shortages, and the system is one of the causes of regional and inter-provincial tension in Canada. The system is also focused on the past, excluding many people who are self-employed or work in the modern gig-economy.

I encourage policymakers and politicians to consider my EI proposal as a way to fix the obvious inequitable nature and backwards incentives of the current system, encourage more stable higher-wage employment, and create a savings pool that Canadians can use to increase their employability, manage periods of unemployment, and provide security in retirement.

Will anyone have the courage to change EI and is a $295,000 taxpayer incentive enough? Here is hoping so!